"Prospect theory is a theory of behavioral economics and behavioral finance that was developed by Daniel Kahneman and Amos Tversky in 1979."
A model of decision-making that accounts for the asymmetry between gains and losses, and the diminishing sensitivity to gains and losses as the magnitudes increase.
Decision-making under uncertainty: The traditional economic model assumes that people are rational and always make the best decision based on available information. Prospect theory shows that people are risk-averse when it comes to gains, but risk-seeking when it comes to losses.
Loss aversion: This is a key concept in prospect theory. People tend to feel the pain of losing more than the pleasure of gaining, which affects their decisions.
Reference point: In prospect theory, the decision maker's reference point plays a critical role in determining the value of both gains and losses.
Framing: How a problem or decision is presented (framed) can affect people's choices. For instance, when a choice is presented as a gain, people are more likely to take risks, while when presented as a loss, people are more likely to be conservative.
Probability weighting: People tend to overweight small probabilities and underweight larger ones, leading to decisions that may not be optimal.
Mental accounting: People tend to compartmentalize their money and assets, which can affect the way they make financial decisions.
Anchoring and adjustment: The initial value of a reference point can influence decisions, even when it is arbitrary or irrelevant.
Certainty effect: People tend to overvalue certain outcomes over uncertain ones, even when the uncertain option has a higher expected value.
Endowment effect: People tend to value things they own more than equivalent things they don't own.
Status quo bias: People tend to stick with what they have and not make changes, even when there are better options available.
Prospect theory and public policy: Understanding how people make decisions and behave can help policymakers design more effective policies.
Prospect theory and marketing: Marketers use prospect theory to understand how consumers evaluate products and services.
Prospect theory and finance: Prospect theory can explain some puzzling phenomena in financial markets, such as why investors tend to sell winning stocks too early and hold on to losing ones too long.
Reference-dependent preferences: Individuals evaluate gains and losses based on their reference point, rather than absolute gains or losses.
Loss aversion: People tend to weigh losses more heavily than gains of the same magnitude.
Diminishing sensitivity: The marginal value of gains or losses decreases as the size of the potential gain or loss increases.
Probability weighting: People tend to overestimate the likelihood of rare events and underestimate the likelihood of common events.
Mental accounting: People categorize their money into different accounts and allocate money to those accounts based on different criteria, such as the source of the money or its intended purpose.
Framing effects: The way a problem or decision is presented can influence the choices people make.
Choice overload: When presented with too many options, people can become overwhelmed and may not make a decision at all.
Anchoring and adjustment: People tend to rely heavily on an initial anchor when making a decision, even when the anchor is irrelevant or arbitrary.
Prospect theory paradoxes: There are several situations in which the predictions of standard rational choice models do not align with empirical observations, such as the Allais paradox, the Ellsberg paradox, and the Asian disease problem.
"The theory was cited in the decision to award Kahneman the 2002 Nobel Memorial Prize in Economics."
"Based on results from controlled studies, it describes how individuals assess their loss and gain perspectives in an asymmetric manner."
"For example, for some individuals, the pain from losing $1,000 could only be compensated by the pleasure of earning $2,000."
"Thus, contrary to the expected utility theory (which models the decision that perfectly rational agents would make), prospect theory aims to describe the actual behavior of people."
"In the original formulation of the theory, the term prospect referred to the predictable results of a lottery."
"However, prospect theory can also be applied to the prediction of other forms of behaviors and decisions."
"Prospect theory challenges the expected utility theory developed by John von Neumann and Oskar Morgenstern in 1944."
"Prospect theory challenges the expected utility theory developed by John von Neumann and Oskar Morgenstern in 1944."
"Prospect theory aims to describe the actual behavior of people, contrary to the expected utility theory which models the decision that perfectly rational agents would make."
"Based on results from controlled studies, it describes how individuals assess their loss and gain perspectives in an asymmetric manner."
"Prospect theory constitutes one of the first economic theories built using experimental methods."
"It describes how individuals assess their loss and gain perspectives in an asymmetric manner."
"For some individuals, the pain from losing $1,000 could only be compensated by the pleasure of earning $2,000."
"Prospect theory is a theory of behavioral economics and behavioral finance."
"The theory was cited in the decision to award Kahneman the 2002 Nobel Memorial Prize in Economics."
"In the original formulation of the theory, the term prospect referred to the predictable results of a lottery."
"Prospect theory can also be applied to the prediction of other forms of behaviors and decisions."
"Based on results from controlled studies, it describes how individuals assess their loss and gain perspectives."
"Prospect theory aims to describe the actual behavior of people."